Sovereign debt: Uruguay juggles cheap yields and regional flux
Plans to pre-fund 2017 in second quarter; Brazil and Argentina imperil growth and investment.
Uruguay plans to pre-fund its 2017 debt requirements by raising between $1 billion and $2 billion in the international and local markets. However, the success of any international transactions will hinge on the sovereign’s ability to alleviate investors’ concerns about a deterioration in the country’s inflation outlook and fiscal accounts – as well as fears that it could suffer contagion from the deep recession in Brazil and a likely recession in Argentina this year.
Herman Kamil, director of the debt management office at Uruguay’s ministry of economy and finance, confirmed that, despite the sovereign holding $3 billion in liquid assets (enough to cover the next one-and-a-half years of debt service) he expects to issue new bonds this year.
Uruguay has adopted a conservative pre-funding policy, which means that Kamil wants to begin evaluating options for issuing in the international markets in the second quarter of 2016, with an eye to pre-funding its 2017 needs.
“Our gross financing needs in 2016 are estimated to be around $2.2 billion. As of end-2015, total liquid assets amount to $3 billion,” says Kamil. “As a result, we estimate between $1 billion and $2 billion of issuance in external and local markets this year, subject to market conditions.”
Like other investment-grade issuers, Uruguay is attracted to issuing in euros. “The relatively low rates in these markets could offer attractive alternatives for us in terms of the fiscal impact of raising debt,” says Kamil. “In the case of the euro we are seeing very low coupons driven by the ECB’s monetary stimulus. To this, we could add that another likely rate cut in Europe, followed by a rate hike in the US that could consolidate the Fed-ECB monetary policy divergence, could benefit those borrowing in a currency that is expected to weaken.”
Herman Kamil, Uruguay’s ministry of
However, an education process will be required to reassure investors that the country isn’t suffering too much from the economic problems afflicting its neighbours.
“From a macroeconomic perspective I am worried about the Uruguayan economy,” says Carl Shepherd, fixed income portfolio manager at Newton Investment Management (part of BNY Mellon). “Although its economy hasn’t had the mismanagement that Brazil and Argentina have suffered, there has to be a point at which the country starts to import economic difficulties from its neighbours.”
Shepherd adds: “The Uruguayan peso hasn’t devalued anywhere near as much as the other regional currencies; at some point, these two factors have to start to eat into Uruguay’s export numbers. Also, further economic orthodoxy from [Argentinian president Mauricio] Macri could start to see some of the Argentine capital that has been resident in Uruguay flow back home – which would have a big impact on investment in the country, in particular in the real estate and construction industries. So although the country is well-managed, I just can’t imagine that Uruguay will escape the turbulence in its neighbouring economies unscathed.”
However, Kamil argues this perspective is out- of-date: “Not long ago, recessions experienced in Uruguay’s biggest neighbours systematically spilled over to the country – more often than not with amplified effects. Yet over the last few years Uruguay has been able to decouple itself from the volatile regional business cycles.”
The data backs this up: despite economic troubles in neighbouring countries, Uruguay grew at an average of 6% between 2005 and 2010, and close to 5% between 2010 and 2015. In 2015 Uruguay grew around 1.5% in real terms, despite the deep recession in Brazil (contracting 3.5%) and the stagnation of the Argentine economy.
“Back in 2005, exports to Mercosur countries represented roughly half of Uruguay’s external sales,” says Kamil. “Today, Uruguay sells goods to about 150 countries, and sales to Mercosur are less than a quarter of the total exports of goods.”
Foreign direct investment
Another driver of Uruguay’s solid economic performance, has been a boom in foreign direct investment into different productive sectors, lured by fiscal incentives and a friendly business climate.
However, Kamil acknowledges that Uruguay is not completely insulated from the negative impacts from the region. “Although Uruguay’s regional economic linkages have lessened, a worse-than-expected slowdown in our biggest neighbours could significantly weigh on Uruguay’s economy,” says Kamil. He points to the deepening recession in Brazil, which could impact on growth in Uruguay in 2016 through weaker external demand.
Meanwhile, the outlook from Argentina is altogether rosier. Since the new government of Argentina took office last December, it has lifted many trade, currency and trans-shipment restrictions that were hurting Uruguay’s economic activity. Uruguay has since notoriously benefited from an increase in tourism from Argentina and more export services tied to merchandise traded through the port of Montevideo.
“We do not expect an economic recovery in Argentina to cause a capital flight,” says Kamil. “Uruguay remains a powerful attractor of foreign direct investment flows coming from Argentine residents into the farmland and real estate sectors. More generally, we think that Uruguay stands to benefit from Argentina’s move to become more integrated to the world of commerce, logistics and financial flows.”
The fiscal deterioration is the key economic issue for international investors, with Itaú saying Uruguay’s fiscal balance rose to 3.8% of GDP in January 2016 from 3.5% in December 2015. Kamil says fiscal consolidation is the “top priority” and the country’s five-year budget commits to gradually narrow the overall fiscal deficit to 2.5% by 2019.